Keith Miles Attorney-at-Law 2250 Oak Road PO Box 430 Snellville, GA 30078 678-666-0618 mileslawoffice@gmail.com www.TimeToEstatePlan.com
Caution: Different rules apply to non-U.S. citizens. The 2010 and 2012 Tax Acts allow the executor of a deceased spouse's estate to transfer any unused estate tax exemption to the surviving spouse without the use of a credit shelter trust. The executor of the first deceased spouse's estate must file an estate tax return on a timely basis and make an election to permit the surviving spouse to use the deceased spouse's unused exemption.
Suitable clients
Spouses with combined assets that exceed the estate tax exemption, which is $5,340,000 (in 2014, $5,250,000 in 2013--double these amounts for a married couple).
Example
John and Mary are a married couple who own $9,680,000 in assets in 2014. Assume the basic exclusion amount is $5,340,000 and the top estate tax rate is 40%. The basic exclusion amount is assumed to increase by 2% annually (with appropriate adjustments for indexing and rounding applied to projections of the exclusion below), the estate assets are assumed to grow 4% annually, and Mary is assumed to die 10 years after John. If John dies leaving everything to Mary, there will be no federal estate taxes due because, generally, the law allows an unlimited amount of property to pass to a spouse free of estate taxes. John's estate elects to pass his unused $5,340,000 exclusion to Mary. Mary can live off the earnings of the entire $9,680,000 estate. When Mary dies, her entire estate will pass to their children. When Mary dies 10 years later, Mary's estate will have grown to $14,328,765 and her basic exclusion amount will have increased to $6,510,000. Mary's applicable exclusion equals $11,850,000 ($6,510,000 + John's unused $5,340,000 exclusion). The excess of Mary's estate over Mary's applicable exclusion is subject to taxes. That means that $991,506 would have gone to the IRS and $13,337,259 would have gone to John and Mary's children (assuming no other variables). Taxes would consume 6.9% of their combined estates. Now, let's say that John executed a will leaving an amount equal to his available exemption to a credit shelter trust, and the rest of his estate to Mary. Say John's gross estate was $6 million. $5,340,000 passed to the trust tax free under John's exemption, and $660,000 passed directly to Mary tax free under the unlimited marital deduction. Mary can live off the earnings of her $4,340,000 estate ($3,680,000 plus $660,000), and can also access the income earned by the trust, as well as the principal of the trust to the extent she needs it for her health, education, maintenance, and support. If Mary died 10 years later, Mary's estate will have grown to $6,424,260 and her basic exclusion amount will have increased to $6,510,000; the assets in the trust, which have grown to $7,904,504, would not have been included in her gross estate. John and Mary's children would have received the entire corpus of the trust. Of Mary's $6,424,260 estate, all of it would have passed to their children tax free under Mary's exemption, and nothing would have passed subject to tax. That results in $0 that would have gone to the IRS and $6,424,260 that would have gone to John and Mary's children. When their estates are combined, the children would have received
$14,328,765. Taxes would consume 0% of the combined estates. By using a credit shelter trust, John and Mary's children would have received an additional $991,506 of their parents' estates that the IRS would have received had the trust not been used. Tip: If John didn't want the property to go outright to Mary, John could leave the residuary estate to a marital trust instead, naming Mary as the primary beneficiary. When a credit shelter trust is used in conjunction with a marital trust, the arrangement is usually called an A/B trust arrangement.
Calculations
Without Credit Shelter Trust Mary's Taxable Estate Tentative Federal Estate Tax - Unified Credit Federal Estate Tax *** Mary's Estate - Federal Estate Tax Mary's Net Estate + John's Net Estate $14,328,765 $991,506 $13,337,259 $0 $14,328,765 $5,677,306 $4,685,800 $991,506
Combined Net Estate $13,337,259 With Credit Shelter Trust Mary's Taxable Estate Tentative Federal Estate Tax - Unified Credit Federal Estate Tax *** Mary's Estate - Federal Estate Tax Mary's Net Estate + John's Net Estate $6,424,260 $0 $6,424,260 $7,904,504 $6,424,260 $2,515,504 $2,515,504 $0
Combined Net Estate $14,328,765 Net Estates With Credit Shelter Trust $14,328,765
Advantages
Achieves tax goal while giving surviving spouse maximum access to and control over trust assets With this type of trust, if the children of the marriage are minors or have special needs, or if the surviving spouse were to otherwise need the money, he or she would be able to access the property that passes to the trust under the deceased spouse's exemption (although access would be limited, see Disadvantages). Preserves assets for descendants Because assets that fund the credit shelter trust bypass the surviving spouse's estate, they are preserved for the ultimate intended beneficiaries. This can be especially attractive when there are children from a previous marriage. Protects assets from future creditor claims Because a bypass trust is irrevocable, future creditors of the beneficiaries (the surviving spouse or the children) will be unable to reach the assets while they are in the trust. So, this strategy also works well if the children are adults and the parents don't want them to own property outright for some reason. If this is the case, a spendthrift provision should be included in the trust agreement.
spouse will have to be careful when withdrawing principal to make sure the money's use will fall within these parameters. Adds complexity to the surviving spouse's life If the surviving spouse is trustee, he or she will have to maintain separate records for the trust, and ensure that he or she does not overstep the trustee's powers. If a neutral trustee is used, the surviving spouse will have to cooperate with the trustee.
Impact of portability
For the estates of persons dying in 2011 or later, the executor may transfer any unused estate tax exemption to the surviving spouse. While this portability has some appeal, it also has issues: In the case of multiple marriages, only the most recent deceased spouse's unused exemption may be used by the surviving spouse. Although the estate tax exemption is portable, the GST exemption is not. Couples seeking to create trusts for the benefit of their children and more remote descendants cannot take advantage of portability because the first spouse's GST exemption cannot be transferred to the second spouse. Any unused exemption is not indexed for inflation. As a result, if the assets transferred to the surviving spouse appreciate, the appreciation may be subject to estate taxation at the surviving spouse's death. Assets passing directly to an individual are subject to the claims of creditors, as explained above (see Advantages). The executor must make an election on a timely filed estate tax return. Such an election, once made, is irrevocable.
Disadvantages
Surviving spouse's access to the credit shelter trust must be restricted The deceased spouse can give the surviving spouse access to all, a portion, or none of the income from the credit shelter trust. If access to principal is allowed, it must be limited to health, education, maintenance, or support only. Health, education, maintenance, and support, or "HEMS", are four magic words used by the IRS, and there's some guidance about what they mean, but the surviving
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